Scandinavian Working Papers in Economics
Memorandum,
Oslo University, Department of Economics
No 10/2010: Contagious Mortgage Default
Øystein Børsum
Additional contact information
Øystein Børsum: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Abstract: This paper analyses the default option typical to American mortgages. House-holds borrow to buy durable housing, but future house prices are uncertain, and households find it advantageous to default on their debt if house prices fall suffi- ciently. A key assumption of the model is that households are relegated to the rental market upon default, and that there is a small pecuniary inefficiency (“iceberg cost”) in renting. This leads defaulters to substitute consumption of other goods for housing; that is, the demand for housing falls upon default. Consequently, when some households default, aggregate demand for housing is reduced, hence house prices fall more, possibly inciting other households to default. This complementarity is a source of multiple equilibria, and a price externality. Using a specific case for which an analytical solution can be derived, I show that contagion is possible: it may be that the default of a minority (interpretable as sub-prime borrowers) spreads to a majority (interpretable as prime borrowers).
Keywords: Housing demand; Mortgage market; Default risk; Multiple equilibria Contagion
36 pages, June 29, 2010
Full text files
Memo-10-2010.pdf
Questions (including download problems) about the papers in this series should be directed to Mari Strønstad Øverås ()
Report other problems with accessing this service to Sune Karlsson ().
This page generated on 2024-04-17 00:05:48.